Sumeet Jain talks derivatives at #TC2016, Bangkok May 2016

1. 11
Structured by
SJ
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2. Definition of Options
 An options contract gives buyer the right, but not the obligation to buy or
sell a specified underlying at a set price on or before a specified date e.g.
Insurance
Options Terminology:Options Terminology:
 Index options: Have index as the underlying.
 Stock Options: Have stock as the underlying.
 Option buyer: Buys the option by paying premium and gets the right to
exercise options on writer/seller.
 Option seller: Sells/writes the option and receives the premium and is
hence under obligation to buy/sell asset if the buyer exercises option.
 Option premium: Price paid by the buyer to seller to acquire the right.
Comprises of Intrinsic Value and Time Value.
 Strike / Exercise price: Price at which the underlying may be purchased or
sold.
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3. Derivative Indicators (Options)
 PRICE-VOLUME
 OPEN INTEREST
 PUT-CALL RATIO
 VOLATILITY:
o IMPLIED
o HISTORICAL
 ROLLOVERS
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4. Derivative Indicators – Acquiring Data
 We need data for these indicators
 Where to find that data?
 Is NSE website enough?
 Introduction to Option Chain and Bhavcopy
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5. Derivative Indicators – Option Chain
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6. Derivative Indicators – Option Chain
 Highest OI Concepts
 Concepts with addition/unwinding of OI
 Is it a Buying rally or a short covering rally
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7. What is BHAVCOPY?
 Bhavcopy is the file which contains all the information about
various scrips being traded on exchange
 There are different bhavcopy for different types of exchange
and marketand market
 In NSE, there is different bhavcopy for Quities, FNO,
Commodities, etc
 Similarly, In BSE, the bhavcopy contains prices of various scrips
on any particular day
 https://www1.nseindia.com/products/content/all_daily_repor
ts.htm
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8. OPEN INTEREST
 Open Interest (OI), also referred to as Open Contracts, is the
number of contracts outstanding in the market. Open Interest
applies to both, Futures and Option contracts.
 For each buyer of a futures contract there must be a seller. For each buyer of a futures contract there must be a seller.
From the time the buyer or seller opens the contract until the
counter-party closes it, that contract is considered 'open'.
 Interpretation: Changes in OI either confirm price action or act
as a warning of a potential change of trend.
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9. Price, Volume and Open interest Relationship
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10. Components of Options Premium
 Current Price of the underlying asset (S)
 Exercise Price of the option (X)
 Interest Rates (Rf) Interest Rates (Rf)
 Time to Expiry (T)
 Volatility of prices of the underlying asset ()
(Options are priced using the Black-Scholes Model and/or
Binomial (Cox-Ros-Rubenstein) Model)
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11. Factors affecting options prices
 Stock price
Call options - more valuable with the rise in price and less
valuable with the fall in price
Put options - more valuable with the fall in price and lessPut options - more valuable with the fall in price and less
valuable with the rise in price
 Strike price
Call options - more valuable at the lower strike and less
valuable at the higher strike
Put options - more valuable at the higher strike and less
valuable at the lower strike
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12. Factors affecting options prices – Contd.
 Risk free interest rate
Call option premium increases with rise in interest rates
Put option premium decreases with rise in interest rates
 Time to expiry
Options are more valuable when the time to expiration is
more
Eg: Nifty Options 8000 CE May’ 2016 series week on week chg
 Dividend
Stock price reduces on the ex – dividend date. This has a –ve
effect on calls and +ve effect on puts
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13. Factors affecting options prices – Contd.
 Volatility
It is a measure of risk, uncertainty or the variability in the
future price of a stock
Higher volatility reflects greater expectations of fluctuations in
either direction for a stock
Options are more valuable with increase in volatility
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14. HISTORICAL VOLATILITY
 Historical volatility indicates how volatile the security has been
in the past.
 Historical Volatility is a weighted average of the annualized
standard deviation of daily percentage price changes of thestandard deviation of daily percentage price changes of the
security and is expressed as a percentage.
 There also exists a strong co-integration between the Historical
& the Implied Volatility wherein, the crossover of HV over IV
sets a trend reversal.
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15. IMPLIED VOLATILITY
 Implied volatility is the market's opinion of the volatility of the
option's underlying security. The implied volatility is calculated using
an option pricing model, such as the Black Scholes model
Implied Vols is determined using the following inputs:
 The price of the underlying security
 The market price of the option
 The strike price of the option
 The expiration date of the option
 The interest rate and dividend yield, if applicable
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16. Negative Correlation between Nifty & Implied
Volatility
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17. PUT CALL RATIO (PCR)
 The Put-Call Ratio (OI) is the ratio of OI in Put Options divided
by the OI in Call Options at a given time.
 While typically the Open Interest is used to compute the Put-
Call Ratio, it is also calculated using traded volumes of Puts toCall Ratio, it is also calculated using traded volumes of Puts to
Calls
 Interpretation: The PCR can be used to determine the
sentiment of market participants, especially when they may be
getting either too bullish or too bearish.
 The range for Indian markets is 0.8 to 1.2 – Bullish and 1.7-1.9
- Bearish
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18. NIFTY-PCR Graph
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19. ROLLOVER
 Rollover means closing out a position in the current-month
futures contract and taking a similar position on the next-
month futures contracts.
Interpretation:
 The Analysis for the rolls in Index Futures & Stock Futures is
done by taking cues from their Historical Avgs.
 LONG & SHORT Rolls can be identified through Rollover
Analysis by using indicators like Price-Volume-Delivery action
and Cost of Carry.
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20. How to Trade Options?
Following these steps can help initiating a position in Options
 Determine your market outlook – Bullish, Bearish or Determine your market outlook – Bullish, Bearish or
Consolidating and degrees of bullishness/bearishness – High
Conviction, Moderate conviction or Low conviction
 Initiate the corresponding strategy – which strategy fits the
outlook, choose ideal strike prices/expiry as per that view
 Keep Reviewing the strategy
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21. How to Trade Options? Contd.
 Selection of Strike Price – Strong, Moderate and Low
conviction trade ideas
 Options with Supports/Resistances – Buy Calls/Write puts at
supports and on breakouts of resistances, Buy Puts/Write Callssupports and on breakouts of resistances, Buy Puts/Write Calls
on Resistances and breakdown of supports
 Options with Oscillators – Buy Calls/Write Puts when RSI is
near 30 and Buy Puts/Write Calls when RSI is above 70
 When ADX is above 25 and +DI is above –DI buy calls – it’s a
market trending upwards, when –DI is above +DI buy Puts as
it’s a market trending downwards, ADX line below 25 – Write
Strangle and Straddles
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22. How to Trade Options? Contd.
 Parabolic SAR and MACD – Buy calls on early buying signals on
these oscillators and Buy Puts on early sell signals
 Widening Bollinger Bands indicate an increase in Volatility and
one can buy options here as a trending move can be expectedone can buy options here as a trending move can be expected
whereas narrowing indicates decrease in volatility so selling
options is advisable
 In any type of option trade a 50% stop loss on premium paid or
received is a must
 Different exit strategies can be used
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23. Writing Options – A deadly game!
 Trading is a game of Probabilities
 After you buy a Stock/Option – there are 3 possibilities
1. It will go up
2. It will go down2. It will go down
3. It wont go anywhere
 If we assign a 33.3% probability to each of the above 3 outcomes,
one stands to make money only 33.3% of the times, i.e. when the
position is favorable
 But if you are writing an options you have a 66.67% probability of
winning!
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24. Writing Options – A deadly game!
 Since Time decay kicks in as the time to expiration decreases, even a
small consolidation would help.
 Writing Straddles and Strangles – Understanding UBEP and LBEP
 How to hedge or employ stop losses in case of options writing
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25. Do's & Don'ts of Options Trading
 Don’t trade in deep out of money options
 Maintain stop loss
1. Price
2. Time2. Time
 Never shift your levels in a Strategy A
 Never Square off only one leg of position in any strategy.
 Book Loss when momentum in the underlying index/stock
dries out.
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26. Options Strategies
Types of Options Strategies
 Straddle
 LONG
SHORT SHORT
 Strangle
 LONG
 SHORT
 Covered Call
 Spreads
 BULL
 BEAR
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27. STRADDLE
Definition:
An options strategy with which the investor holds a position in both a call
and put with the same strike price and expiration date is called a Straddle.
Objective:
 Long Straddle is done to capture wild movement in the underlying, ideally
before result or an event.
Eg. BUY NIFTY 5400 PE & CE simultaneously.
 Short Straddle is done when you believe that a stock's / Index price will not
move up or down significantly.
 Eg. SELL NIFTY 5400 PE & CE simultaneously.
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28. Straddle Payoff
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29. Strangle Strategy
 Definition:
An options strategy where the investor holds a position in both a call and put with
different strike prices but with the same maturity and underlying asset. This
option strategy is profitable only if there are large movements in the price of the
underlying asset.underlying asset.
 Objective:
o An trader may take a long strangle position if he thinks the underlying security
is highly volatile, but does not know which direction it is going to move
Eg: BUY NIFTY 5300 PE & 5700 CE
o When the options trader thinks that the underlying stock will experience little
volatility in the near term. Short strangles are credit spreads as a net credit is
taken to enter the trade.
Eg: BUY NIFTY 5400 PE & 5700 CE
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30. Strangle Payoff
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31. Covered Call Strategy
 A covered call is a financial market transaction in which the
seller of call options owns the corresponding amount of the
underlying instrument, such as shares of a stock or other
securitiessecurities
Eg: Long Reliance Eq /Fut. at INR 825
Short Reliance 860 CE @ 12.5
Maximum Profit:47.5 per share
LOSS : Unlimited
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32. Covered Call Payoff
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33. Spreads
 Simultaneously buying and selling options with different strike prices
establishes a spread position
BULL
 The bull call spread option trading strategy is employed when the options The bull call spread option trading strategy is employed when the options
trader thinks that the price of the underlying asset will go up moderately in
the near term
Eq: Buy Nifty 5400 CE SELL NIFTY 5600
BEAR
 The bear put spread option trading strategy is employed when the options
trader thinks that the price of the underlying asset will go down
moderately in the near term.
Eq: Buy Nifty 5500 PE & Sell Nifty 5400 PE
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34. Spread Payoff
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